The benefits (and costs) of change
An oft-cited benefit of Topic 606 was its convergence with the revenue recognition standard issued by the International Accounting Standards Board (IASB), which brings helpful consistency to financial statement users and preparers. Participants also commented that the principles-based nature of Topic 606 facilitates easier communication about accounting results with both internal stakeholders and investors. An ancillary benefit of implementing Topic 606 is enhanced communication among accountants and other stakeholders in the revenue cycle, such as business development, financial planning and analysis, and legal teams.
On the other hand, participants observed that the broad impact of Topic 606 has led to increased expenses for most companies in initial implementation and ongoing compliance costs as companies continue to expend considerable resources to evaluate both existing and emerging revenue streams. A frequent comment by roundtable participants was that the increased judgments and estimates required under Topic 606 (for example, estimating variable consideration) are primary drivers of higher recurring costs.
An evolving world
As today’s revenue arrangements grow increasingly complex, so too does the application of accounting guidance intended to convey the economics of such arrangements. Across the board, participants noted various challenges of applying an accounting standard that could not have anticipated all facets of today’s business environment, almost 10 years from its issuance, including the following:
Identification of performance obligations
The identification of distinct performance obligations has significant downstream implications within the five-step model of Topic 606 – and yet, a lack of specific guidance can make it difficult to make this determination. Identifying performance obligations often requires not only accounting expertise but also accounting teams with a deep, cross-functional understanding of a company’s business, its product or service offering, and how those products or services are marketed to customers.
Determination and allocation of transaction price
When a company is providing a novel product or service, or otherwise has little demonstrable pricing history, estimating a stand-alone selling price often involves a significant degree of judgment. Similarly, the inclusion of variable consideration within a transaction price necessitates documented and auditable estimates, requiring a company to contemplate factors such as the probability of meeting certain milestones, rates of return, or potential reversals.
Principal versus agent, and other considerations
Topic 606 offers limited guidance to help companies determine whether they are acting as a principal or an agent, another area requiring the application of significant judgment. Companies face ambiguity in weighing the list of nonexhaustive considerations provided by the guidance and in determining what alternative factors, if any, should be considered. Companies that provide novel services or licenses of intellectual property, such as software, often find it especially challenging to assess their “control” over these products prior to delivery to a customer.
Multi-party transactions and transactions that occur outside of the bounds of a traditional contract add additional layers of complexity. And as an increasing number of companies provide a platform rather than directly providing a good or service, many find their indirect relationship with the end user causes even more complication. Those companies might question how to account for price concessions and other incentives provided to their customer’s customer.
Noncash consideration
In seeking new ways to manage cash flow, many companies have opted to include equity awards as a form of consideration in revenue contracts, leading to challenging interactions between applicable accounting standards – such as guidance in Topic 718, “Compensation – Stock Compensation.”
